Eddie Stobart Logistics

Transcription

1 Eddie Stobart Logistics Life in the fast lane Initiation of coverage Industrial support services Through a mixture of winning new outsourced logistics contracts, exposure to the substantially higher-growth e-commerce subsector and solid underlying market growth, we forecast that Eddie Stobart Logistics (ESL) will grow EBIT at 15.3% CAGR over the next three years. Since being taken private in 2014, ESL has brought in new management and grown earnings significantly. Listing on AIM in April 2017 enabled the company to pay down debt, make a small acquisition and set the business up for the next phase of expansion. Despite its sector-leading operations and outlook, ESL trades at a discount to its global peers. We believe it should trade at least in line and our fundamentals-based valuation per share of 200p offers equity holders upside of 26%. 19 June 2017 Price 158.5p Market cap 567m Estimated net debt ( m) at 30 November Shares in issue 357.9m Free float 72.2% Code Primary exchange ESL AIM Secondary exchange N/A Year end Revenue ( m) PBT* ( m) EPS* (p) DPS (p) P/E (x) Yield (%) 11/ N/A 11/ N/A 11/17e /18e Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments. Share price performance Growing e-commerce and profitability drive returns ESL s scale, technology and network drive operating margins ahead of its closest listed UK and European peers. Operating profit growth will be driven by the top line, however, with a mixture of market growth, the contribution of substantially higher growth from e-commerce, plus, most significantly, winning new outsourced logistics contracts all combining to drive 13.6% three-year underlying revenue growth. ESL s superior operations will, we believe, facilitate a 3.5% dividend yield starting this year, which is an attractive differentiator in a sector that yields 1.1%. Bolt-on acquisitions look set to continue ESL completed the 45m strategic acquisition of iforce in April The UK transport and logistics sector remains very fragmented with hundreds of potential targets of a similar scale to iforce. ESL s balance sheet capacity plus marketleading fleet utilisation, technology and management means the company can make and extract significant synergies from bolt-on acquisitions, which will further drive shareholder returns. Valuation: Underpriced versus growth prospects Trading on an FY18e EV/EBIT of 11.5x and P/E of 12.9x, ESL trades below a global average of its peers (14.2x and 19.8x, respectively). However, ESL s superior profitability (7.4% EBIT margins versus a sector average of 5.0%) and growth profile (EBIT growth of 15% CAGR versus low single-digit percentages in the sector) deserve a premium to its peers. This view is reinforced by our fundamental valuation of 200p per share. The 26% upside to current trading levels is derived through three valuation methodologies: DCF, peer comparison and an economic value added (EVA) analysis. % 1m 3m 12m Abs (2.2) N/A N/A Rel (local) (2.7) N/A N/A 52-week high/low 163.5p 158.5p Business description Eddie Stobart Logistics is a market leader in endto-end multi-modal transport and logistics. Operations are primarily focused in the UK with some activities in mainland Europe. Key customer segments include retail, consumer, industrials and, increasingly, e-commerce. Next events Q2 results July 2017 Analysts Jamie Aitkenhead +44 (0) Roger Johnston +44 (0) industrials@edisongroup.com Edison profile page Eddie Stobart Logistics is a research client of Edison Investment Research Limited

2 Investment summary Change in focus drives stellar earnings growth ESL is among the largest UK transportation and logistics market participants, albeit with only around 1% of the fragmented 70bn market. Management estimates that between 45% and 80% of logistics and supply chain services are carried out in-house, which accounts for ESL s relatively small market share despite being in the top five contractors by revenue. Road transportation of goods in trucks still accounts for the bulk of revenues. The group has refocused to growth areas such as e-commerce and changed its model to be a provider of consulting-led outsourced logistics management. ESL is differentiated by its above-average profitability and growth pipeline. It listed on AIM on 25 April Valuation: Fair value per share of 200p and 26% upside ESL currently trades at a discount to its closest peers. Its FY18e EV/EBIT ratio of 11.5x and price to earnings ratio of 12.9x compares to sector averages of 14.2x and 19.8x, respectively. Given ESL s sector-leading EBIT (three-year CAGR 15.3%) and EPS growth (three-year CAGR 27%) we believe the stock should trade at least in line with its global peers. Our fundamental analysis implies a fair value per share of 200p, which offers 26% upside to the current price of 158.5p. We arrive at our fair value per share by taking an average of three valuation methodologies. Our DCF (WACC 7.4%, terminal growth 1%) implies a value of 190p. We also use a peer comparison adjusted for superior growth, which gives a value of 200p. We also make use of an EVA analysis, which gives a fair value of 207p per share. A simple average of the three gives our fundamental fair value per share of 200p. Financials ESL exhibits significant earnings growth. Q117 delivered: results showed 18% revenue and 20% EBITDA growth, confirming continuing strong growth and providing a reassuring outlook. Balance sheet: we forecast net debt to one-year forward EBITDA to drop from 3.4x at the end of November 2016 ( 166m) to 1.4x at the end of November 2017 ( 79m), leaving room for further acquisitions. Sensitivities: Risks well handled by management ESL s management has been proactive in addressing specific operating risks. Fuel costs are passed through in all contracts and the cost structure is set up to be flexible. However, a couple of operating and technical risks should be noted: Macro issues: although ESL enjoys the ability to quickly reduce its cost base in response to any economic downturn, thus conserving margins, it should be mentioned that several important client groups, such as Manufacturing, Industrial and Bulk (MIB), which together accounted for 81% of FY16 revenues, are sensitive to GDP trends. Technical issues: with over 50% of the stock held by the top five shareholders, ESL will suffer from a perceived lack of liquidity. Furthermore, there is the possibility that one or more of the larger shareholders could wish to sell down, potentially creating an overhang. Regulatory issues: operating a fleet of over 2,000 trucks, many of which run on diesel (although ESL has markedly increased diesel efficiency), exposes the group to further taxes on road users or emissions. It is likely that ESL would be able to pass through such costs and no major explicit regulatory change is expected soon. Eddie Stobart Logistics 19 June

3 Financial issues: ESL is exposed to cyclical sectors; it could lose as well as win contracts (we believe some of its contracts are meaningful at group level). It may incur a cash cost for the use of the Eddie Stobart brand from 2020 or it might have to buy a perpetual right to do so in Company description: The building blocks of growth ESL continues to evolve from its heritage as primarily a road-based haulier of retail and consumer goods towards providing integrated consulting-led logistics services in higher growth markets such as e-commerce and MIB products. It has 5,500 employees, 2,200 vehicles, 3,800 trailers and four rail-connected distribution centres, which combine into the most profitable UK-based logistics companies. It listed on the AIM market in April 2017, having been in private hands since Exhibit 1: ESL s UK and European distribution network Source: Eddie Stobart Logistics data Several factors differentiate ESL; uppermost among them are the company s highly competitive offerings in price and service. The Eddie Stobart brand (held by licence from Stobart Group Brands, for which ESL may start paying a royalty fee or purchase a perpetual right) is very well-known to UK consumers. Its distribution network across the UK (see Exhibit 1) brings network benefits that translate into low empty-leg journeys and therefore higher fleet utilisation and sector-leading profitability. Investment in recent years in technology means ESL has a modern IT platform, which brings the capabilities in inventory management, real-time tracking and route optimisation sought by complex customers. Management will continue to invest further in technology and in higher growth end-markets, such as e-commerce and building supplies, to enhance the growth prospects of the company in order to sustain above-average industry levels. The recently installed management team with the benefit of the new capital raised at listing have the ambition and platform to grow the business through both organic and inorganic means. CEO Alex Laffey brings with him decades of experience and contacts in UK logistics. Management is applying margin discipline more rigorously and using its reputation and sector know-how to bid for outsourced logistics contracts as they come up. Eddie Stobart Logistics 19 June

4 ESL has longstanding relationships with the largest customers in UK logistics. 75% of its FY16 revenue came from 25 clients and more than half of its relationships have been in place for longer than 10 years. Several aspects of the ESL business proposition are attractive to customers, in addition to price competitiveness. For instance, ESL s contracts are often closed book, which means that, with the exception of a fuel pass-through, ESL takes on utilisation risk from its customers in return for higher rewards. End-market exposure: e-commerce and MIB fuelling the engine ESL s most important end-markets are Retail (27% of FY16 revenues), Consumer (30%), MIB (24%) and e-commerce (9%); however, the e-commerce proportion will increase to more than 20% in FY18e as the iforce acquisition contributes part and then full-year revenues. ESL s three largest end-markets Retail, Consumer and MIB have historically grown in line with GDP while e- commerce is growing by double-digit percentages. UK consumer demand has remained resilient even after the EU referendum result. The key industry trend in recent years has been the switch in consumer demand to non-store retailing at the expense of in-store retailing. Euromonitor estimates that non-store (online) still only accounts for 14.7% of the market. We forecast this trend will continue with traditional in-store Retail and Consumer sectors growing at a GDP plus rate of 2.5% and online sales growing well above. Integrated logistics providers are set to benefit from the changing market due to their warehousing skills and assets, which are attractive to online retailers. Indeed, post iforce, ESL has the second largest e- commerce business in the UK. MIB sectors have displayed a far more diverse set of growth patterns in recent years. Bulk (often rail) shipments of coal and steel have declined significantly, while the construction sector has grown. ESL continues to target more construction customers to exploit this continuing trend. Recognising the diverse range of industries served by ESL, we forecast a GDP plus rate of organic growth of 2.5%. Importantly, ESL aspires to capitalise on the outdated single operator model, which prevails in MIB. Integrated logistics offerings, common in the retail and consumer segments, are yet to fully penetrate MIB clients. Increased market share at the expense of smaller independent names is a key attraction for ESL s management. The e-commerce business is expanding both organically and by acquisition, and is becoming an important part of ESL s business and a significant growth engine. We forecast a 25% growth rate in ESL s e-commerce businesses over the coming years. Taking into account the iforce acquisition and the significantly higher rate of growth in this market, we forecast e-commerce will account for at least 20% going forward. Exhibit 2: ESL revenue split by end-market exposure Historical revenue split by end-market 120% 100% 80% 60% 40% 20% 0% 8M Consumer Retail MIB Adhoc Sector E-commerce EBITDA margin (%) EBIT margin (%) 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Source: Eddie Stobart Logistics data, Edison Investment Research Eddie Stobart Logistics 19 June

5 Exhibit 3: ESL s EBIT margins ahead of the pack last reported FY data 8.0% ESL vs peers EBIT margin (%) 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% ESL Wincanton Clipper ID Logistics Kuehne & Nagel Panalpina Deutsche Post Royal Mail Average (excl ESL) Source: Eddie Stobart Logistics data, Edison Investment Research ESL s network model, investment in technology, high on-time delivery record and scale contribute to its highly efficient operations. The result is an FY16 EBIT margin of 7.4%, which is around 250 basis points ahead of the average of its closest peers. In a highly competitive and mature market, this is a considerable achievement. With 47,000 deliveries per week enabled by a network-based approach that ensures fewer empty leg journeys and IT systems enabling route optimisation, ESL generates vehicle utilisation well above the industry average, near-perfect scoring on on-time deliveries (see Exhibits 5 and 6) and a strengthening brand reputation. Exhibit 4 shows the benefits of having exposure to complementary sectors. For instance, when MIB deliveries stop at 17:00, the same curtain-sided trucks can be used for e-commerce customers in the evening. Management has stated it will not actively seek to expand EBIT margins much from current levels. Rather it will invest in headcount and other costs to better service customers. Exhibit 4: Complementary sectors bring network effects Source: Eddie Stobart Logistics data Finally, Alex Laffey s focus on margin discipline was illustrated well with the June 2016 cessation of the Tesco Ireland contract and also its exit from the Britvic contract. Eddie Stobart Logistics 19 June

6 Exhibit 5: ESL vs peer vehicle utilisation (2016) Exhibit 6: ESL s on-time deliveries (2016) 100.0% 99.3% % vehicle utilisation 80.0% 60.0% 40.0% 20.0% 0.0% ESL Industry average % deliveries on time 99.2% 99.2% 99.1% 99.1% 99.0% 99.0% 98.9% Source: Eddie Stobart Logistics data Source: Eddie Stobart Logistics data Operating flexibility in place for downside protection Several of ESL s key customer segments such as MIB (24% of FY16 revenues) are cyclical. The company has built flexibility into its cost structure to absorb reductions in revenues from economic contractions. For example, ESL leases its vehicles from Volvo and Scania. The company can adjust its fleet size downwards by up to 300 trucks out of a total of 2,200 as part of the lease agreement. Also, with approximately one-third of its leases up for renewal annually, it can reduce its fleet size quickly to absorb the impact of softening end-markets. Taken together with ESL s use of subcontractors on short-term contracts, agency drivers who account for up to 25% of all drivers and the company s ability to manage headcount flexibly, there are several mechanisms in place where management can rapidly adjust the cost base to offset any future decline in revenues. Long-term relationships account for the bulk of revenues The bulk of ESL s revenues come from long-term contracts. CEO Alex Laffey, previously in charge of in-house logistics at Tesco, is a well-established and respected name in the sector. Management stresses that relationships and reputation are very important in the sector and the fact that 25% of ESL s relationships, many with blue chip customers, are over 10 years old illustrates the company s perceived quality as a counterparty. With 67% of ESL s FY16 revenue from existing contracts, such arrangements demonstrate stability and add visibility to group cash flows. Added to this, the company has a rolling pipeline of m of new business split between existing and new clients. Note: evergreen contracts are rolling annual renewals. Exhibit 7: ESL FY16 revenue split by contract type Noncontracted 13% Exhibit 8: ESL FY16 revenue split by contract duration 0-2 years 5% 2-4 years 11% Evergreen 20% 4-6 years 11% Contracted 67% 10+ years 60% 6-8 years 4% 8-10 years 9% Source: Eddie Stobart Logistics data Source: Eddie Stobart Logistics data Eddie Stobart Logistics 19 June

7 M&A opportunities while balance sheet headroom remains We forecast ESL s year-end FY17e net debt will be 79.1m, equivalent to 1.4x EBITDA with 130m in proceeds from the April 2017 IPO, enabling the company to pay down some debt and to complete the April m acquisition of iforce, an e-commerce company. We fully expect management to continue with its policy of making selective bolt-on acquisitions as long as the company remains below its self-imposed net debt to LTM EBITDA ceiling of 2x. The UK transportation and logistics market is very fragmented (ESL s market share in 2015 was under 1% of the total market value of 70.3bn) so there is no shortage of potential small targets around. iforce was acquired for 45m. Based on 55m of revenues and 6.5% operating margins (company guides to above 6%), ESL paid a reasonable multiple of around 12.5x trailing EBIT for iforce, which is well below market multiples for similar companies such as Clipper, which trades at more than 20x forward EV/EBIT. When high revenue growth is taken into account, ESL probably paid well below 12.5x forward-looking EV/EBIT. iforce, once on ESL s operating platform, will gain access to ESL s customers and operating capabilities, which will immediately enhance the performance of the target and produce synergies. Operations and forecasts ESL reports by operating activity Road Transport, Contract Logistics (CL) and Warehousing, EU Transport and Other. We briefly discuss each operating division in the following section. Exhibit 9: ESL FY17e revenue split by segment Other Divisions, central and eliminations 8% EU Transport 7% Exhibit 10: ESL FY17e EBITDA split by segment CL & EU Transport Warehousing 5% 11% CL & Warehousing 17% Road Transport 68% Road Transport 84% Source: Edison Investment Research Source: Edison Investment Research Q117 strong growth reflects market growth and contract wins In the three months to February, ESL grew quarter-on-quarter revenue and EBIT by 18% and 20%, respectively. Management commented that the high growth was due to a mixture of contract wins in 2016 and organic growth, and that it continues to invest in existing customers and pipeline. It is worth noting that Q1 is normally the slowest month as it captures January and February, which see a drop-off in demand following Christmas. We forecast ESL will grow revenues at a CAGR of 13.6% over the next three years from 570m in FY16 to 836m in FY19e. As Exhibit 14 shows, organic growth increases as iforce gives the company more exposure to the high growth e-commerce segment: e-commerce accounted for 9% of FY16 revenues, which increases to over 20% pro-forma with iforce. The fact that ESL is one of only a handful of logistics operators that can undertake complex, nationwide logistics outsourcing contracts, and that, in addition, the CEO used to work for Tesco, convinces us the company is well placed to win new contracts in the coming years. With large retail, consumer and industrial customers continually inviting tenders for 20-40m per year contracts (ESL, significantly, recently won a 28m per year contract in the aggregates space), it only takes one or two such new Eddie Stobart Logistics 19 June

8 contracts per year to increase revenues by mid- to high-single-digit percentages as per our forecasts. The final revenue growth driver is M&A. We only explicitly forecast the iforce acquisition (in for part of FY17e and all of FY18e) and Stobart Ireland disposal, which are both complete. We forecast ESL s e-commerce end-market will grow at 25% year-on-year while the other divisions Retail, Consumer, MIB, Other will grow at a far lower 2.5%. We take on board management guidance where it expects that the largest reporting segment, Road Transport, will grow by a higher rate than the other divisions as it has greater e-commerce exposure. Road Transport: MIB and e-commerce the engines of growth Road Transport (68% of FY16 revenues) is where the bulk of the MIB and e-commerce growth will come through. There will be a one-off effect in FY17e from the disposal of the Irish operations, which contributed 21m of FY16 revenues. Excluding this, we expect underlying three-year EBITDA CAGR of 9.1%. We expect margins to stay flat over our forecast period in line with historical reported figures. Exhibit 11: Road Transport EBITDA and margin forecasts EBITDA, m e 2018e 2019e 13.0% 11.0% 9.0% 7.0% 5.0% 3.0% 1.0% EBITDA margin, % EBITDA Margin Source: Eddie Stobart Logistics data, Edison Investment Research iforce: Allocating capital to higher growth markets With 2016 revenues of c 55m and operating margins above 6%, the 45m acquisition (implied EV/EBIT multiple of 12.5x based on 6.5% EBIT margins) of e-commerce specialist iforce early in 2017 offers ESL increased exposure to this high-growth segment. Note that it is unclear whether ESL will account for iforce as a separate reporting segment or split it between Road Transport and CL and Warehousing. For transparency and until we get confirmation from management, in Exhibit 14, we split out the iforce contribution. iforce s activities complement ESL s existing logistics operations. It offers an end-to-end service and has sophisticated software in areas such as fulfilment management, carriage management, returns and stock clearance, which fits with ESL s outsourcing model. The acquisition makes strategic sense for ESL as it gains a foothold in a highgrowth market and new software, plus ESL will be able to extract synergies as it brings iforce onto its scale platform. CL and Warehousing: Stable returns CL and Warehousing (17% of FY16 revenue) tends to be a slower growth business. We therefore forecast this division to report a three-year EBITDA CAGR of 24.1%, partly driven by 7.5% revenue CAGR and partly by our forecast of a margin recovery to 6.0% after FY16, during which ESL expanded its warehousing capacity and therefore saw lower margins as rent payments increased. Management now guides to capacity utilisation having increased enough for margins to recover. Therefore, we expect EBITDA margins to remain around 6.0% across the forecast period. Eddie Stobart Logistics 19 June

9 Exhibit 12: CL and Warehousing EBITDA and margin forecasts EBITDA, m e 2018e 2019e 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% EBITDA margin, % EBITDA Margin Source: Eddie Stobart Logistics data, Edison Investment Research EU Transport: Dipping a toe in Europe Although small, accounting for only 7% of FY16 revenue, we forecast the EU Transport business will grow at a rate in line with the broader group with 7.5% revenue CAGR. We also forecast EBIT margins of 6% for the next three years, in line with the average of the last two years. However, we note EU Transport s strong margin performance in FY16, and do not expect this level to be sustained; hence our three-year EBITDA CAGR for this business is -5.6%. Exhibit 13: EU Transport EBITDA and margin forecasts EBITDA, m e 2018e 2019e 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% EBITDA margin, % EBITDA Margin Source: Eddie Stobart Logistics data, Edison Investment Research Further growth through bolt-on acquisitions iforce is a good example of what we believe will be an active programme of bolt-on acquisitions for ESL. At the time of listing, management indicated it was assessing three further targets. Taking into account the 2x net debt to last-12-month EBITDA (currently 1.6x) ceiling ESL has set itself in conjunction with its annual free cash generation of c 10m from FY18e, we calculate that ESL has scope to make acquisitions totalling up to c 30m over the next year or two. In a highly fragmented market, there is no shortage of potential targets. Forecast earnings growth ahead of the industry Pulling together our divisional estimates (see Exhibit 14), we generate our three-year forecast EBIT CAGR of 15.3%, driven by top-line growth rather than operating margin expansion. Despite the fact that industry reports such as the one published by KPMG in March 2017 estimate that transport and logistics as a whole will only grow by an average of 2.5% to 2021, we believe ESL can grow organically at mid- to high-single-digit percentages. We highlight again the m rolling pipeline of new contracts disclosed by ESL at the IPO. Our underlying three-year revenue growth Eddie Stobart Logistics 19 June

10 forecast (excluding one-off effects of the iforce acquisition and the disposal of the Irish operations) is 11.8%. ESL s superior growth is driven by a mixture of exposure to higher growth market segments such as e-commerce and the likelihood of it winning large-scale ( 20-50m per annum) outsourced logistics contracts from large retailers. As an example of the scale of opportunity, a 40m outsourced logistics contract would boost ESL s revenues by more than 7% alone. We bring together each of our individual reporting segment revenue forecasts into the group revenue growth forecasts below with growth split between organic, net new business and M&A. Exhibit 14: Detailed ESL revenue forecasts Revenue m e 2018e 2019e Comments Road Transport e/15: 6.8%; 3-year CAGR 9.8% Total y-o-y (%) 19.8% 6.8% 11.7% 11.0% Organic y-o-y (%) 4.5% 4.5% 4.5% 90% traditional at 2.5%, with (ex iforce) e-commerce 10% at 25% Net new business y-o-y (%) 7.7% 7.2% 6.5% One 30m contract per year M&A (%) -5.4% 0.0% 0.0% Ireland ( 21m) removed in FY17 Underlying (organic plus new business) (%) 12.2% 11.7% 11.0% CL & Warehousing e/15: 7.5%; 3-year CAGR 7.5% Total y-o-y (%) 8.4% 7.5% 7.5% 7.5% Organic y-o-y (%) 2.5% 2.5% 2.5% 2.5% organic growth assumption Net new business y-o-y (%) 5.0% 5.0% 5.0% Assume 5% net new business M&A (%) 0.0% 0.0% 0.0% Underlying (organic plus new business) (%) 7.5% 7.5% 7.5% EU Transport e/15: 7.5%; 3-year CAGR 7.5% Total y-o-y (%) -19.8% 7.5% 7.5% 7.5% Organic y-o-y (%) 2.5% 2.5% 2.5% 2.5% organic growth assumption Net new business y-o-y (%) 5.0% 5.0% 5.0% Assume 5% net new business M&A (%) 0.0% 0.0% 0.0% Underlying (organic plus new business) (%) 7.5% 7.5% 7.5% Other divisions, central and eliminations e/15: 7.5%; 3-year CAGR 7.5% Total y-o-y (%) 31.3% 7.5% 7.5% 7.5% Organic y-o-y (%) 2.5% 2.5% 2.5% 2.5% organic growth assumption Net new business y-o-y (%) 5.0% 5.0% 5.0% Assume 5% net new business M&A (%) 0.0% 0.0% 0.0% Underlying (organic plus new business) (%) 7.5% 7.5% 7.5% iforce Total y-o-y (%) 80.0% 40.0% Organic y-o-y (%) 30.0% 30.0% 30% organic growth Net new business y-o-y (%) 10.0% 10.0% Assume significant new contracts M&A (%) 40.0% 0.0% Phase in over two years Total e/15: 13.7%; 3-year CAGR 13.6% Total y-o-y (%) 14.8% 13.7% 14.5% 12.7% Organic y-o-y (%) 3.9% 5.4% 6.3% New business y-o-y (%) 6.9% 6.7% 6.4% M&A (%) 3.0% 2.3% 0.0% Source: Edison Investment Research We forecast ESL s operating margins will remain around % across our forecast period. The company s margins are well ahead of its nearest competitors (Exhibit 2), which is due to ESL s scale and efficiency. ESL does take on utilisation risk through its closed book contract but there is a fuel cost pass-through in all contracts. Management points out that ESL has weathered economic downturns well in the past and preserved margins, through a mixture of flexibility in its lease agreements, its ability to increase and reduce subcontractors and agency drivers, and the company s capability to cut costs quickly. Likewise, management would reinvest (ie expense more to cap margins) in the business rather than let margins continue to rise. A lower interest charge due to ESL paying down some debt post capital raise, together with high EBIT growth, combines to drive our three-year (Edison definition pre-amortisation and exceptionals) underlying EPS CAGR of 27.4%. Furthermore, we assume ESL will start paying a Eddie Stobart Logistics 19 June

11 dividend this year on the basis of a 50% payout of underlying earnings. This implies an FY17e DPS of 5.5 pence per share, which implies a dividend yield of 3.4%. IFRS 16: Operating lease accounting changes and their impact From 2019, in common with all other companies, ESL will change how it accounts for its operating leases. It will bring an asset and a liability on to its balance sheet and the 72m annual lease payment, instead of being expensed, will be split between depreciation and interest. Both net assets and EBIT will remain identical, but EBITDA will increase significantly. According to its admission document, under IFRS 16 FY16 EBITDA would increase by 72m to 118.7m. In the EVA analysis section below, we discuss how this might affect ESL s fair value, including what we believe to be an appropriately higher WACC due to the increase in net debt. Until we know specifics on the impact of future changes, we have not altered our forecasts to reflect it. A second order effect of this change would be an increase in ESL s clients outsourcing their logistics operations. Retail and consumer goods companies might not want to increase their net debt (and therefore creditworthiness) by bringing operating leases onto their balance sheets and so may be more likely to seek to outsource their logistics operations. ESL, among others, would benefit in this scenario. Management Each of ESL s top managers has significant experience running large organisations. Most have held senior roles, either within ESL or in logistics roles in other large organisations. They bring a wealth of both contacts and experience to the firm. Chairman: Philip Swatman Philip Swatman has extensive capital markets experience, having been a managing director and subsequently co-head of investment banking of NM Rothschild between 1998 and 2001, before serving as vice-chairman of investment banking until He has served as a non-executive director at nine companies. CEO: Alex Laffey Appointed in May 2015, Alex is an international logistics expert with over 25 years experience in supply chain distribution at a senior level. He headed international distribution for Tesco and managed Tesco s UK logistics, with over 50,000 store deliveries per week and a 1.6bn annual cost base. CFO: Damien Harte Damien has over 30 years experience in senior financial positions at large organisations across a range of sectors in the UK and internationally, including logistics and distribution, manufacturing, renewable energy, media and leisure. COO: David Pickering David Pickering has worked for Eddie Stobart for over 25 years and as chief operating officer has leadership of operations directors, spanning manufacturing, industrial & bulk, e-commerce, retail and consumer. Eddie Stobart Logistics 19 June

12 Sensitivities As is to be expected, the nature of ESL s business points to a number of stock-specific and general economic risks. Macro issues: Retail, Consumer and MIB, which together accounted for 81% of FY16 revenues, are GDP-sensitive in nature. In an economic contraction, goods volumes would decline. On a more macro level too, a hard Brexit that involves restrictions on free movement of labour could potentially lead to a shortage of drivers, although ESL has been proactive in ensuring it has sufficient resources by such means as establishing a driver staffing JV called Logistics People. Customer and contract issues: while we forecast ESL will add new contracts each year, we acknowledge the risk that ESL fails to win new contracts. There is also a risk of customer churn, which, given the high degree of customer concentration, could pose a material risk to revenues. Also, given ESL s contracts are closed book, low utilisation will challenge margins in the short term. M&A risks: given it is ESL s strategy to pursue acquisitions, we should acknowledge that there is execution risk, financing risk and risk associated with the new businesses acquired. Technical issues: over 50% of the stock is held by the top five shareholders. With a lower than 300m effective free float, liquidity is relatively low and this may preclude large funds from investing. Furthermore, there is the possibility that one or more of the larger shareholders, notably the private equity holders, could wish to sell down their stake, potentially creating an overhang. Regulatory issues: operating a fleet of over 2,000 trucks, many of which run on diesel (although ESL has markedly increased diesel efficiency), exposes the group to further taxes on road users or emissions. It is likely that ESL would be able to pass through such costs and no major explicit regulatory change is expected soon. Financial issues: ESL may incur a cash cost for the Eddie Stobart brand from 2020 or it might have to buy a perpetual right to use the brand in Financials Boosted by the 130m raised from the IPO on 25 April, and after the 45m iforce acquisition in April 2017, ESL carries a strong balance sheet and is cash-generative, leaving scope for further bolt-on acquisitions and payment of a dividend. Cash flow: Asset light model leaves ample cash for dividends Due to ESL s asset-light model the company leases its fleet of 2,200 trucks and 3,800 trailers from Volvo and Scania the company s capex requirement is low. We forecast investments of around 7m per year in PP&E, which is just over 1% of sales. The largest drag on cash flow is working capital; we forecast that FY18e receivables alone will absorb cash flow of 21m, although we note that management has extended its discounting facility to 60m from 40m to tackle its working capital drag. With our forecast FY18 underlying EBITDA of 64.4m, net interest of 5.5m, tax of 6.7m, net working capital of 11.5m and capex of 7m, ESL will have ample cash to cover our forecast cash dividend cost of 22.1m (final FY17e dividend and interim FY18e dividend) and pay down some debt. Eddie Stobart Logistics 19 June

13 We expect the company to continue to actively seek small-scale, bolt-on acquisitions, which will be financed mainly through debt. We do not include acquisitions other than those already announced in our earnings forecasts. Balance sheet: Keep on bolting-on At the end of November 2016, ESL had net debt of 165.5m. It raised 129.7m from the IPO in April and used 45m of the proceeds to buy iforce. We forecast it will generate 24.7m of operating cash flow in FY17 and net interest, tax, capex and dividends will absorb 23.4m, resulting in our forecast FY17 net debt figure of 79.1m. Given balance sheet strength and our forecast that ESL will start paying dividends in FY17, we believe the company will finance M&A mainly through debt. Management has publicly stated it will look to make small acquisitions in the highly fragmented UK transportation sector and has put in place a debt ceiling of 2x the last 12 months (LTM) EBITDA. We estimate that end November 2017 net debt/ebitda will be a conservative 1.4x, down from 3.4x at the end of November Valuation We value ESL using multiple valuation methodologies: discounted-cash-flow (WACC 7.4%, terminal growth 1%), peer multiple comparison and EVA analysis. Our fair value per share of 200p is based on the average of these three methodologies and offers equity holders an attractive 26% upside to the current price of 158.5p per share. Peer comparison: 26% upside We base our peer multiples comparison-driven fair value on global average one-year forward EV/EBIT multiples. These are typically used in the transport and logistics sector globally as this measure removes different accounting treatments of operating leases (see comment on page 11 relating to upcoming accounting changes for operating leases). Exhibit 15 shows a global average EV/EBIT of 14.2x. The UK average one-year forward EV/EBIT is 13.1x with a significant valuation differential between perceived e-commerce-focused operator Clipper, trading on 22.0x, and traditional logistics company Wincanton, which trades on 8.6x. Following its iforce acquisition, ESL will earn more than 20% of its revenues from e-commerce. Furthermore, it compares very favourably to Wincanton in terms of revenue growth (13.6% three-year revenue CAGR versus consensus revenue CAGR for Wincanton of 3.0%). We forecast ESL will continue to outperform Wincanton on EBIT margins (FY17e 7.5% versus 4.6% for Wincanton according to consensus). In addition, it offers a 3.5% dividend yield versus Wincanton s consensus forecast dividend yield of 3.0%. We consequently apply a 14.0x EV/EBIT multiple for ESL and note that our multiple-based fair value per share of 200p implies a reasonable price-earnings-to-growth ratio of less than 1.0x. Eddie Stobart Logistics 19 June

14 Exhibit 15: Peer comparison table Company Share price (local) Market cap (local, m) Dividend yield Current P/E Next P/E Current EV/ EBIT Next EV/ EBIT Net debt to +1y EBITDA Deutsche Post AG , % 14.7x 13.7x 11.3x 10.4x 0.5x Kuehne + Nagel International AG , % 25.1x 23.4x 18.7x 17.3x -0.7x DSV A/S , % 24.1x 21.1x 19.6x 17.4x 1.6x Panalpina Welttransport Holding AG , % 33.1x 26.0x 21.1x 16.5x -2.2x ID Logistics Group % 36.3x 22.3x 20.1x 14.6x 0.5x XPO Logistics Inc , % 31.1x 21.0x 16.1x 12.7x 3.3x Average Global 1.6% 27.4x 21.3x 17.8x 14.8x 0.5x Clipper Logistics PLC % 35.6x 29.7x 26.1x 22.0x 0.7x DX Group PLC 1.1x Wincanton PLC % 10.6x 10.2x 8.9x 8.6x 0.4x Royal Mail PLC , % 11.2x 10.7x 8.8x 8.6x 0.4x Average UK 3.3% 19.1x 16.8x 14.6x 13.1x 0.7x Average Global 2.2% 24.7x 19.8x 16.7x 14.2x 0.6x Eddie Stobart Logistics % 14.4x 12.8x 13.2x 12.2x 1.4x Source: Edison Investment Research, Bloomberg data. Note: Priced on 14 June DCF: 20% upside Our DCF valuation of 190p is based on five years of explicit earnings forecasts after which point we take a terminal value with a 1% terminal growth rate. Our WACC is 7.4%. Exhibit 16: Discounted cash flow analysis m p/share EV ( m) FY17e net debt ( m) Current number of shares (m) Fair value ( m) Current market cap ( m) Upside / (downside) (%) 18.9% DCF ( m) 2017e 2018e 2019e 2020e 2021e Terminal value EBIT Less cash taxes (2.3) (6.8) (8.2) (8.6) (9.0) Tax rate -4.6% -12.1% -12.7% -12.7% -12.7% NOPLAT Working Capital (12.7) (11.5) (15.0) (15.8) (16.5) Add back depreciation Less capex (7.5) (7.0) (7.0) (7.4) (7.7) Free cash flow FCF growth 17.7% 11.4% 5.0% 5.0% 1.0% WACC 7.4% 7.4% 7.4% 7.4% 7.4% 7.4% Year Discount factor Discount cash flow NPV EV/EBITDA 13.5x 11.7x 10.2x 9.7x 9.3x Source: Edison Investment Research Exhibit 17 shows our valuation with a range of WACC assumptions. A 2% increase in the WACC decreases the implied value by 26% to 140p. A 2% decrease in the WACC increases the fair value by 50% to 282p. Eddie Stobart Logistics 19 June

15 Exhibit 17: DCF sensitivity to WACC (p/share) Terminal growth Discount rate (post-tax, nominal) 5.4% 6.4% 7.4% 8.4% 9.4% 0.0% % % % % Source: Edison Investment Research EVA: 31% upside We believe ESL s return on capital employed (ROCE) should be properly calculated in order to complete an EVA analysis. In our preferred ROCE measure, we take account of operating leases that are currently accounted for off balance sheet and we deduct intangible assets that relate to a previous acquisition. We add back 72m operating lease cost to NOPAT as this should be accounted for as a finance charge. We add the value of the right-of-use asset ( 462m) to ESL s capital employed and we add the liability (also 462m) to our net debt estimates. Given the fact that our FY17e net debt to EBITDA increases from 1.4x to 4.3x using this methodology, we feel it appropriate to increase ESL s WACC, which we currently assume is 7.4%, to 9.5% to reflect the significantly higher leverage. The net result of these changes, shown in Exhibit 18, is an FY18e ROCE of 21.0% and a WACC of 9.5% giving a ROCE/WACC multiple of 2.2x. We gross up ESL s capital employed by 2.2x and deduct net debt of 539m in arriving at our FY18e fair value per share of 207p, which offers equity holders 31% upside to current levels. For completeness, in Exhibit 18 we also show our calculations for ESL s ROCE based on two other definitions of capital employed: a simple ROCE calculation and a ROCE minus intangible assets calculation. This is to give investors the ability to flex the value per share depending on their own definition of ROCE. Eddie Stobart Logistics 19 June

16 Exhibit 18: EVA analysis ( m ) e 2018e 2019e Simple ROCE calculation Capital employed (total fixed assets including amortisation + current assets current liabilities) NOPAT (underlying EBIT tax) ROCE (%) 14.1% 15.1% 15.7% 17.2% WACC (%) 7.4% 7.4% 7.4% 7.4% ROCE/WACC multiple (x) 1.9x 2.0x 2.1x 2.3x Net debt Net debt/ EBITDA (x) 3.4x 1.4x 1.0x 0.7x EVA fair value (ROCE/WACC capital employed liabilities) Fair value per share (pence per share) Excluding intangibles ROCE calculation Capital employed (total fixed assets including amortisation + current assets current liabilities) Intangibles Capital employed less intangibles NOPAT (underlying EBIT - tax) ROCE (%) 59.1% 47.3% 42.7% 41.0% WACC (%) 7.4% 7.4% 7.4% 7.4% ROCE/WACC multiple (x) 8.0x 6.4x 5.8x 5.6x Net debt Net debt/ EBITDA (x) 3.4x 1.4x 1.0x 0.7x EVA fair value (ROCE/WACC capital employed liabilities) Fair value per share (pence per share) Including operating lease ROCE calculation Capital employed (total fixed assets including amortisation + current assets current liabilities) Intangibles Operating lease liability Capital employed less intangibles plus operating lease liability NOPAT (underlying EBIT tax) Operating lease cost EBIT pre operating lease cost ROCE (%) 21.1% 21.1% 21.0% 21.4% WACC (%) 9.5% 9.5% 9.5% 9.5% ROCE/WACC multiple (x) 2.2x 2.2x 2.2x 2.3x Net debt (adjusted for 472m operating lease liability) Net debt/ebitda (x) 5.3x 4.3x 3.9x 3.6x EVA fair value (ROCE/WACC capital employed liabilities) Fair value per share (pence per share) Source: Edison Investment Research Eddie Stobart Logistics 19 June

17 Exhibit 19: Financial summary m e 2018e 2019e Year-end 30 November IFRS IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue EBITDA Operating Profit (before amort. and except.) Intangible Amortisation (9.5) (9.5) (9.5) (9.5) (9.5) Exceptionals (3.1) (2.4) (18.3) Other Operating Profit Net Interest (16.7) (16.0) (7.2) (5.5) (5.3) Profit Before Tax (norm) Profit Before Tax (FRS 3) Tax (1.6) (1.3) (2.3) (6.7) (8.0) Profit After Tax (norm) Profit After Tax (FRS 3) Minority interest Net Income (norm) Net Income (FRS 3) Average Number of Shares Outstanding (m) EPS (pence per share) - normalised EPS (pence per share) - normalised and fully diluted EPS (pence per share) - (IFRS) Dividend per share (pence per share) EBITDA Margin (%) Operating Margin (before GW and except.) (%) BALANCE SHEET Fixed Assets Intangible Assets Tangible Assets Investments Other Current Assets Stocks Debtors Cash Current Liabilities (109.7) (120.1) (135.1) (145.0) (151.5) Creditors (99.6) (110.6) (125.5) (135.5) (142.0) Short term borrowings (5.5) (6.2) (6.2) (6.2) (6.2) Other (4.5) (3.3) (3.3) (3.3) (3.3) Long Term Liabilities (197.2) (198.8) (113.3) (108.3) (103.3) Long term borrowings (168.5) (173.4) (103.4) (98.4) (93.4) Employee benefits Other long term liabilities (28.7) (25.5) (10.0) (10.0) (10.0) Net Assets CASH FLOW Operating Cash Flow Net Interest (12.8) (10.3) (7.2) (5.5) (5.3) Tax (3.9) (1.7) (2.3) (6.7) (8.0) Capex (7.7) (8.1) (7.5) (7.0) (7.0) Acquisitions/disposals (45.0) Financing Dividends (6.5) (22.1) (25.5) Net Cash Flow Opening net debt/(cash) HP finance leases initiated Other (6.1) (10.8) 0.0 (0.0) (0.0) Closing net debt/(cash) Source: Eddie Stobart Logistics data, Edison Investment Research Eddie Stobart Logistics 19 June

18 Contact details Eddie Stobart Logistics Stretton Green Distribution Park Langford Way Appleton Warrington WA4 4TQ Revenue by geography % UK 93% 7% Europe Management team CEO: Alexander (Alex) Laffey Appointed in May 2015, Alex is an international logistics expert with over 25 years experience in supply chain distribution at a senior level. He headed international distribution for Tesco and led a review of the company s global logistics blueprint to realise synergies across all of its markets. This programme delivered significant cost savings and service improvements. In addition, Alex also managed Tesco s UK logistics, with over 50,000 store deliveries per week and a 1.6bn annual cost base. Chairman: Philip Swatman Philip has extensive capital markets experience, having served as a managing director and subsequently co-head of investment banking of NM Rothschild between 1998 and 2001, thereafter serving as vice-chairman of investment banking until Philip has been involved in a significant number of highprofile transactions including the IPO of Vodafone and the sale of BPB to Saint Gobain. Philip has served as a non-executive director at nine companies, including his present roles as a member of the Council of Lloyd s, chairman of Wyvern Partners and non-executive chairman of Cambria Automobiles since CFO: Damien Harte Damien joined ESL in December He has over 30 years experience in senior financial positions of large organisations across a range of sectors in the UK and internationally, including logistics and distribution, manufacturing, renewable energy, media and leisure. Most recently he was global CFO of LM Windpower, a leading player in the global renewable energy market. Damien is a Certified Accountant and holds an MBA from the University of Chicago. COO: David Pickering David has over 25 years logistics experience, having joined Eddie Stobart in 1990 at the age of 17. David has detailed knowledge of Eddie Stobart s operations, spanning the MIB, e-commerce, retail and consumer sectors, and as COO, David leads a team of operational directors in the UK divisions of the business. David is a Chartered Fellow of the Chartered Institute of Logistics and Transport. Principal shareholders (%) Woodford Investment Management 19.29% Greenwhitestar 15.01% Stobart Group 12.49% Axa 6.98% Invesco 5.06% Companies named in this report Deutsche Post (DPW), Kuehne + Nagel (KNIN), DSV (DSV), Panalpina (PWTN), ID Logistics (IDL), XPO (XPO), Clipper Logistics (CLG), DX group (DX), Wincanton (WIN), Royal Mail (RMG) Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. 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Frankfurt +49 (0) Eddie Schumannstrasse Stobart 34b Logistics 19 June High Holborn 295 Madison Avenue, 18th Floor Level 12, Office Frankfurt Germany London +44 (0) London, WC1V 7EE United Kingdom New York , New York US Sydney+61 (0) Pitt Street, Sydney NSW 2000, Australia